Mid and smallcaps expensive, selectivity crucial for investors: George Thomas

Time of India

3 days ago

"Investors should be selective in their
stock picks
because broader
market valuations
are not cheap. Compared to the strong returns of the past three to five years, returns over the next couple of years might be lower, although still reasonably healthy," says George Thomas, Quantum AMC.
If you look at the six-month trajectory, the market is still up by 6%. How do you see the market moving in the near term and the long term with respect to the Nifty and Sensex? More importantly, which sectors should investors consider if they want to allocate capital now?
George Thomas:
If you look at the recent market performance, it's driven by a few key factors. Firstly, the earnings profile of companies has been somewhat muted. For the March quarter, aggregate revenue growth was in single digits—around 6-7% for the BSE 500—while margins remained steady. In such an environment, valuations weren't supportive enough to generate high returns.
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However, looking ahead, we believe a few positive triggers are emerging. For one, the higher-than-expected rate cuts could eventually boost consumption and support some capex projects that may materialize in the coming quarters. The monsoon has also been reasonably good, which should benefit the rural economy. Irrigation activity and kharif sowing have shown healthy trends. With these factors, along with a relatively low base for FY25, we expect things to improve from here.
That said, investors should be selective in their stock picks because broader market valuations are not cheap. Compared to the strong returns of the past three to five years, returns over the next couple of years might be lower, although still reasonably healthy.
Let's elaborate further on the broader markets—specifically midcaps and smallcaps. It doesn't seem appropriate to talk about both market caps in the same breath anymore. Let's discuss them separately. There was a time when investors earned good profits from these segments. Valuations had cooled off a bit, but are we now looking at a time correction in certain pockets? And how are you positioned from a sector-specific valuation standpoint in midcaps and smallcaps?
George Thomas:
For mid- and small-cap investors, selectivity is crucial because there is froth in many areas. In our Quantum Smallcap Fund, for instance, we are holding about 13% in cash—which is higher than usual—reflecting our caution about valuations in that space.
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Some of our recent additions have been in the
auto ancillary sector
and a company catering to the FMCG space. However, investors need to adopt a bottom-up approach—you can't generalize. One must be mindful of valuations and evaluate each company's story individually.
From a broader perspective, mid- and small-caps continue to be expensive compared to their historical averages. Not so much on a P/E basis, but if you look at price-to-book—an indicator of how profits compare to historical trends—there's clear evidence of froth. Hence, selectivity is essential.
The companies we've added in the auto ancillary space are gaining new clients, including both domestic and foreign auto OEMs, and are increasing their components per vehicle. So, investors need to be very selective in this pocket.
Let's shift focus to PSU banks.
Indian Overseas Bank
, for example, just reported a 75% rise in net profit to ₹1,111 crore, and the stock is up 2%. There's been a lot of action in
PSU banks
lately, especially with a 50-bps rate cut already in place and clarity emerging on the rate trajectory. How do you view this space going forward?
George Thomas:
We have been extremely selective in the PSU banking space. We currently hold just one PSU bank that has a large franchise and one of the lowest costs of funds. However, when you move further down the ladder, we believe that management and underwriting quality in many PSU banks do not match the best players in the sector.
We are constructive on the banking sector overall. Even though there could be some near-term margin pressure due to rate cuts, we believe the market has largely factored this in. The asset quality concerns we saw in segments like personal loans, credit cards, and MFIs seem to be behind us.
Looking ahead, we expect asset quality to remain stable, and current valuations have already priced in some of the expected margin compression. Compared to their historical averages, some banking names—particularly in the private sector—continue to offer attractive upside.
I'd like to bring your attention to the chemicals and fertiliser sector. With NITI Aayog recently releasing a roadmap to boost India's chemical industry, does this sector feature in your portfolio? What's your outlook considering the structural changes being proposed?
George Thomas:
We currently have no exposure to the chemical sector, primarily due to concerns around supply-side dependencies. Many of these companies are significantly influenced by how major Chinese suppliers behave, which adds unpredictability.
Moreover, it's hard to identify a sustainable moat in many specialty chemical companies. Their performance often hinges on regional dynamics, and given the scale of their operations, we don't see consistent structural advantages such as cost leadership.
While there could be selective opportunities, from a broader sector perspective, we have not found an attractive combination of valuations and fundamental strength. Hence, we have stayed away from this space in our portfolio.